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Tuesday, November 21, 2017

Staying Afloat: Financial Capital

Last week I wrote about personal and family resilience and outlined ten different types of capital. I defined capital loosely as a useful resource that you have some control over in order to comfortably get you through increasingly uncertain times. The first one of those—which also happens to be the one that most people associate the term capital with—is financial capital. Yes, we're talking about money derived wealth. I'm not going to cover this in any great depth—it is, after all, a blog post—as it is such a huge topic. Instead, see this as a prod for further contemplation, or maybe just as a reminder.

Rich man, poor man

It is commonly accepted that if you have a large enough pile of cash, you'll not only be able to secure your future, but you'll be happy too. We are told that having a high income and stash of other easily converted quasi-financial assets, such as stocks, shares, Bitcoins and a gold-plated pension will make you deliriously happy. However, this is not so. The best way to disavow yourself of this illusion is to stand during rush hour at a commuter station in the heart of London's City district or Wall Street in New York, and observe your fellow human beings as they swarm past. Not only do they not look happy, many of them look downright stressed and angry as they scurry back to their multi million dollar apartments and country mansions. Frankly, some of these stuffed suits look like they are about to burst a blood vessel.

But these are merely the working wealthy. What about people who have already accrued wealth beyond their wildest dreams? To see how well these are doing one only has to open a newspaper or read a biography or two. The former are filled with lurid stories of celebrities, lottery winners and sports stars ruining their lives with cash-fuelled hedonistic behaviour, and in the latter, you will often read of egotistical self-sacrifice, power struggles, lifetime-long legal battles with detractors and an eventual sad and lonely death followed by a drawn-out family squabble as lawyers pick over the will like vultures on a carcass.

Personally this kind of fate doesn't appeal too much to me.

So, if having too much wealth can be a curse, does it follow that having very little wealth will make you happy? Well, of course not. Unless you are Mark Boyle (the 'Moneyless Man') you're going to need to have access to some cash in order to survive, and for most people that means having a job. Now, having a job, in itself, might not make you happy, but at least it allows you to access a flow of money which you will need to get through life. Periodically, however, you may find yourself without the means of making money flow into your pocket, meaning you will suddenly find yourself with no money at all.

Having no money, or not enough to live off, is neither pleasant nor resilience building. If you find yourself in the position where you do not have enough money to support yourself or your family then you will immediately find yourself cannibalising your other forms of capital. You may be forced to sell off valuable items, such as your car. If you sell your car then you may find your scope for travelling to and from work is diminished, making it harder still to find a replacement job. This is the kind of negative feedback loop that is put into effect by a personal financial crisis. Next, you may raid your savings if you have any, just to buy the basic necessities. Perhaps you will similarly turn to credit cards or other form of predatory lending simply to put food on the table and pay the bills.

As time goes by and your situation has not improved you will be increasingly stressed and worried. When you get stressed your body and mind put themselves into an elevated threat mode. And as they don't know the nature of the threat, they prepare for every eventuality, which is why being stressed is so draining. Because of this your health capital will suffer. You may lose your appetite, you won't be able to sleep properly, and any addictions you have may spiral out of control. You may even develop new addictions — such as sleeping pills or prescribed opiates — as you desperately try to stop the stress from draining your life force. Eventually, if this continues, you may end up falling out with your partner, getting thrown out of your home and end up staring into the abyss thinking "What happened?"

Once the financial rug has been pulled out from beneath your feet a system of negative feedback loops will rapidly assert itself and trying to get back on your feet can feel like attempting to haul yourself out onto dry land from the set of rapids you've just fallen into. It is really quite a terrifying situation to be in, and one that is best avoided at all costs (as I can personally testify).

Yet this, unfortunately, is the scenario that more and more people are facing as our economies become increasingly threadbare. Today's economic reality is that more and more wealth is concentrated at the top rather than distributed more equitably, and at the same time the apparatus and mighty institutions of health, social security and state-backed pension provision that were put into place during an era of great prosperity during the second half of the 20th century are staring at bankruptcy.

Given these realities, any rational person would not want to be placed at either end of the financial wealth spectrum, and would instead opt for a happy medium. And given that not too many of us are likely to find ourselves accidentally falling into the most wealthy 1%, we only have to worry about being relegated to the status of financial non-entity class. Once you are relegated to this economic sub-class, where the best job you can hope to find is a zero hours contract on minimum wage, and any downward adjustment in your government allocated wage support will have a cataclysmic effect of you and your family, you are going to find it almost impossible to pull yourself out of it again. And given that this sub-class is rapidly swelling in size across the industrialised world and gobbling up people as if Godzilla and his extended family were at an all-you-can-eat buffet, what can you really do to avoid being a victim?

Control
Chaos and stress occur when you are not in control. To get control of your financial capital you first need to do an appraisal. If you're familiar with using spreadsheets then great, but a piece of paper and a pencil will also suffice. Make a note of all your income and all your outgoings on a monthly basis. If you don't know some of the figures then make a realistic estimate but brutal honesty with oneself is required in this exercise. Do the calculations to account for a few months, or even a year.

What is revealed? Do you spend more than you earn, or do you have a nice sum left over each month? If it's the former then you are going to have to find ways to either cut your outgoings or increase your income. Obviously, some of your costs will be fixed, but perhaps they can be reduced? It pays to think carefully abut what you are paying for both your fixed costs and your variable ones, and make actionable changes accordingly. There are many, many ways in which you can reduce your variable costs—and there are many websites and books out there packed with tips—so I'll just mention a few to get the thought processes rolling although, of course, everyones' circumstances are different. You could, for example:

- Cancel any entertainment packages you are signed up to and do something less passive instead
- Buy ingredients in bulk and make large pots of food, freezing individual portions for later eating
- Search around for cheaper utility deals and try to cut your energy and water usage
- Swap your car for a bicycle, or at least go by bike more often
- Forego a vacation rental and instead do a house swap

On the income side of the scale you could, for example:

- Take on an extra part time job
- Make art or crafts and sell them online
- Make value added products from your garden, such as chutneys or marmalade, and sell them at farmers markets
- Get a higher paying job
- Rent out a room in your house

The object of the game is always to live below your means. If you are able to live below your means you can use the excess money to invest in other forms of capital and increase your resilience. You could, for example, spend your spare money on buying fruit trees (bio capital), cooking a huge feast and inviting your neighbours round to eat it (social capital), picking up some quality hand tools from eBay (hard capital) — or you could store it as cash savings, thus increasing your emergency fund (keeping it in the realm of financial capital). Thus by becoming more frugal you can become richer in a more rounded sense.

Speaking of this, one of the first things you will need to do to build financial capital resilience once you have got your income and outgoings tuned, is to build up a savings fund. There are shocking figures circulating that almost 7 out of 10 adults in America cannot put their hands on $500 to cover an unexpected emergency. I'm sure the figures will be similar for Britain and other first world nations, especially if anecdotal evidence is anything to go by. The fact is that most people are living wage slip to wage slip, or from one government handout to the next. Your immediate aim should be to ensure you are not one of them. A good target to aim at would be to have enough cash saved up to cover six months of expenditures for you and your dependents. Of course, this is just a target—any money at all that you can put aside will make you just that bit more resilient in the financial stakes. If six months seems somewhat extreme and unattainable, start with one month.

And when I say cash, I mean actual notes that you can put in your pocket. Any money that you have stored in a bank account is not technically yours at all, but the bank's. As all banks operate on a fractional reserve basis (that is, they only have something like 1/10 of the money that is on their balance sheet at any one time, the rest being all manner of convoluted investments, derivatives and loans), they will not be able to give it back to you if sufficient numbers of other people also ask for theirs back at the same time. This is called a bank run, and legislation is already here in Europe to protect banks against this happening by limiting the amount of liability they have with regard to your savings.

It is important to consider financial capital first because, with the exception of every other form of capital (except perhaps health), a financial disaster has the ability to bring down your carefully constructed house of cards. To that end we should first consider ...

Debt

We are riding high on the biggest debt bubble in history. This should terrify most people, and yet it rarely gets a mention. In fact, many younger people—including some economists—who have grown up in this debt bubble simply see it as 'normal' and assume it will continue to inflate forever. History tells us otherwise.

The fastest growing form of debt in the UK is consumer debt. We are bombarded with enticements to buy new stuff, to upgrade cars and phones and to splash out on holidays and computer games and a million other things.

But debt, in actual fact, must be repaid, otherwise it would never be lent in the first place. And so you must ask yourself before you take on any debt whether it is likely to increase your resilience or not. Not all debt is bad, just as not all savings are good, but think very carefully about taking on debt and always try to avoid it if you can. Because taking on a debt means handing over a portion of your future security to a faceless entity that does not care about you or your wellbeing: all it cares about is getting its money back, with interest.

At the very least, you should never take on debt to purchase consumer products or services. I know it's easy to be tempted, and we all have our weaknesses, but consumer debt can be an Achilles heel for many. Whenever I forget this simple fact I sit down and watch one of the many popular debt-collection TV shows and imagine it's my front door that the dull-eyed jobsworth debt collectors are kicking down at dawn, and my family they are forcing out onto the street. Because being in debt and finding you are unable to make payments is a sure fire way to set you on the road to financial oblivion.

So, if you have much unsecured debt, make it a priority to reduce and eliminate it. If you have a large amount of "secure" debt (in quotes because no debt is secure, from your point of view), such as a mortgage, also consider how you might reduce that, perhaps by moving to a smaller or cheaper property, or making increased monthly payments. The less debt you have, the less you'll have to worry about if/when there is a prolonged economic seizure.

Stocks and bonds

Known as 'paper wealth' stocks and bonds are certificates that purport to represent the value of a company or government or other real-world entity. Their price is determined by both the yield that they pay out (i.e. a sum of money paid periodically to the owner of the certificate) and the market's take on its true value based on its riskiness. Shares, generally, tend to be riskier than bonds, as bonds are underwritten by the central banks of national governments and are therefore deemed "safe".

But remember, no form of investment is "safe". Like other forms of paper wealth (futures, derivatives, hedge funds etc), stocks, shares and bonds are only an abstract representation of an underlying reality in the physical world, and their value can plummet to zero overnight. In fact, with the advent of high-speed computer trading, their value can plummet to zero in nanoseconds.

At present, stock markets around the world seem to be rising inexorably. The main reason for this is the huge amounts of financial stimulus being pumped into financial markets in the wake of the last crisis ten years ago. We are long overdue for a massive correction in this regard.

Gold and precious metals

It's common to see articles about financial planning and resilience end up by recommending readers buy gold as a means of securing their wealth (with a handy link to the author's favourite bullion merchant). I'm not going to do that. I don't believe that buying gold will do you an awful lot of good, unless you are extremely wealthy and really cannot sleep at night without thinking your future security is stored in a lump of yellow metal in a Swiss vault. The reason I don't believe that buying gold bars is a good idea is several-fold.

Firstly, they are eminently worthless unless you are able to liquidate their value in a safe manner. Given that gold is a safe haven, it has a consistently high value. It's very stealable. Should a financial collapse occur and word gets out that you have some gold buried somewhere then it's just a matter of time before you and your family receive a night visit from a group of gentlemen carrying duct tape, cable wire and garden secateurs. This exact scenario was very common in Argentina following their financial crisis in 1998. And given that it's impossible to sell physical gold without telling someone that you own it, there's no way around this scenario. If you own it, you take this risk of someone else finding out you own it, and wanting it.

Secondly, gold is useless. Okay, so it has a few minor uses, such as tooth fillings and fountain pen nibs, but beyond that it has little immediate use. If you really must own some precious metal then silver might be a better bet as it has a host of industrial and non-industrial uses, meaning it will always likely retain some value based on this. And it is less likely to get you in trouble.

And thirdly, gold mining is one of the most environmentally damaging things mankind has ever devised. I'm amazed at the sheer number of articles out there which spend several paragraphs outlining why we need to look after Mamma Gaia, and then go onto recommend buying gold to hedge the future.

Are there any situations where it might be a good idea to hold gold? Sure. Buying a few coins, for example, or holding onto family jewellery or gold ornaments will give you a bit of psychological and financial security without making you such a target. Generally speaking, however, a far better investment would be in hard goods and land. These are the kinds of things that will keep you alive in a prolonged state of emergency in ways that a lump of metal cannot.

Cryptocurrencies

A recent alternative to holding gold or cash, and something that everyone is talking about at the moment, is cryptocurrencies such as Bitcoin. I'll be honest and say that I don't know enough about them to have a fully informed opinion here. When they first appeared my first instinct was "snake oil" — and this has been bolstered by all the overblown claims I have seen lately, usually made by baby-faced millennials who have very little conception of the wider systems in which they operate.

My second thought was that they will clearly be unviable as energy constraints assert themselves — after all, if you have no access to your "wallet" on a smartphone or computer, then you have no access to your money. And then theres the huge amount of energy used by computers to "mine" the data that allows each unit to claim its uniqueness ...

However, several clever people whom I trust and respect have said they see some potential in cryptocurrencies and blockchain technologies as a form of decentralised cash, so I shall research more and develop a more informed view over time.

Anyway, that wraps up this short summary of financial capital as it relates to personal resilience. Next week I'll talk a little about a non-abstract form of capital — hard goods.

I'll end with what I consider to be the seven most important points to consider when building up your financial capital resilience:

1) Live within your means and invest any surplus in other forms of capital
2) Get out of debt as soon as you can — especially if it is non-productive debt
3) Build up an emergency cash fund to last you a good few months
4) Don't rely on paper wealth being a good store of value
5) Don't be a goldbug
6) Don't think you are going to receive much of a pension
7) Don't invest in cryptocurrencies unless you are 100% sure you understand them (nobody 100% understands them ...)

Thank you. Much needed. Money has been on my mind a lot of late. As a self employed building contractor work can be spotty, particularly during the holiday season. I am out of work now; though I do have work upcoming, to last several months, I am feeling the crunch of having spent too much on food, drink and smokables in 2017, such that I am roughly at $0 when factoring in the bills I am putting off. I think I have been at $0 probably 50 different times since 2008, so it is not something that debilitates me, but definitely something I would like not to have to relive again and again. First thing is a more honest assessment about where the money is going.

I agree too, long term, land, tools and the knowledge to use them would seem paramount to resilience, equal probably to social capital, who you know and what they are capable of. I like to think my knowledge of building, gardening and wild foods will help me stay well, based on the future I expect, an ever increasingly difficult economy to navigate, increasingly chaotic.

Wishing though today, I had bought some bitcoin back in 2012-2013, when you could buy it with pocket cash. I thought snake oil too, but that snake oil would make me a good less anxious now. Alas, I was more broke then, than I am now....

Hi William. Looks like we're in similar boats. My main form of cash income comes from a job at a hotel - and it is about to close down for winter renovation work. I have three or four other income streams (or trickles) - yet these have also dried up for the winter. I'm looking at being extremely skint for the next three months - including during a foreign trip I've got booked in December.

During this period I plan on doing a lot of work in my woodland, and writing my next book (after Seat of Mars) - which I'm already some way into. Luckily, my wife has a job that will cover the basics over this period, so there is nothing really to worry about.

Ah yes - if I could just borrow a time machine and buy a few Bitcoins ...

Well, that's kind of reassuring, as I hurtle towards the big 60 without a smidgeon of a pension of my own behind me! I've been aware for a long time that I'm going to have to grow stuff, make stuff & find stuff to sell until I drop, having never been in a position to accrue a pension fund. But luckily, a number of my fellow market traders are "resting luvvies" who also have no pension; the oldest, a very grand old dame of the theatre, is well into her 80s & still as sharp as a gold-plated hatpin. She lives on a miniscule sum that I'd struggle to keep a dog on, and I'm fairly good at not spending money. Also luckily, I enjoy what I do, and don't have any debt, as my Other Half has a 9-5 sort of job that he loves. But our kids can't afford to buy their own homes...

A number of teacher friends of mine are horrified to find that they've worked their socks off for 20-30-odd years (most had career breaks to get their own kids to first-school stage, and went part-time whilst raising their families) and their pension will amount to about £100 a month. And they're often still paying mortgages, having kept them on to pay their kids' way through university... B&Q only have so many jobs for pensioners to go around!

Hi TW. It's all a guessing game but I think it's the people under about 40 that may not see a penny of pension. I'm betting that, at 46, I'll likely get *something* - even if it is a food voucher or some other redeemable subsistence token. The numbers just don't add up when it comes to pensions. Even now we are seeing quite a few pension bombs going off at the municipal level in America - so I expect to see the same thing here soon, with the explosions getting louder and louder all the time. The fact that so many pensions (both public and private) are still paying out is probably down to the stock market being supported by central banks. Once that prop is taken away there will be nothing to support them.

This is the reason I'm trying to cultivate skills that I'll still be able to practice in my dotage - and why I'm so nice to my kids (who will probably end up having to look after me) :-)

A succinct article covering a vastly complicated subject, but I think you've got your bases covered. The foundation for managing financial capital is number one on your list: live within one's means. A debt based economy was fine when the future economy was nearly guaranteed to be larger than the present, making the debt manageable. Facing a different future, we must change our stories and our habits.

My wife and I are still working on this, and it's probably going to be a never ending issue. Managing expectations is the most difficult part.

Having put a good deal of our spare financial capital into our respective career changes, we are taking an educated risk that it'll pay off in the future in a very different world. I can say that I am happy (for the moment) with the decisions I've made.

British budget yesterday and OBR forecasts (and OBR have previously been wildly optimistic) seem to confirm your view, particularly about pensions. Deflation is when you (in aggregate) cannot afford to buy even when the prices do not go up. It seems more than economic incompetence - although we have that too.Ilargi at TAE has an informative take on this today.bestPhil

Hi Phil. Illargi (and Nicole Foss) have done much to educate about what real inflation and deflation are. I think we're in a deflationary spiral right now - with the velocity of money getting lower all the time. Something I read this morning made me laugh, it was an article saying that "Black Friday" in Britain was a flop because consumers are suffering from "bargain fatigue"! Bargain fatigue? More like "not having any more credit fatigue" if you ask me ...

Hi Xabier. Yes, looking at the history books, states that get themselves into too much debt either end up inflating it all away, or taxing their citizens half to death as they try to recoup their losses. Neither one is an attractive proposition but we don't really seem to learn form past mistakes do we ("It's different this time!")